Charitable remainder trusts: What advisors need to know

Written in partnership with Vanilla.

For charitably inclined clients, giving and wealth planning do not have to be separate conversations. A charitable remainder trust (CRT) can allow certain clients to make a significant commitment to charity while retaining an income stream for themselves or other beneficiaries.

CRTs may offer tax-related benefits as well. Clients may qualify for a partial charitable income tax deduction when they fund the trust. And for those with highly appreciated assets, a CRT may provide a way to diversify their holdings without triggering U.S. federal capital gains tax at the trust level when the trust sells the assets, potentially spreading the tax impact over future distributions instead.

Attorneys structure and draft CRTs, but advisors are often the first to recognize potentially valuable estate and tax planning opportunities. Understanding how the strategy works can help you identify clients who may benefit from a CRT and collaborate effectively with their estate planning attorneys and tax professionals to evaluate how a CRT may fit within their broader wealth plan.

What is a charitable remainder trust?

A charitable remainder trust is an irrevocable trust that provides annual income payments to one or more non-charitable beneficiaries, which may include the client who establishes the trust, with the assets remaining at the end of the trust term passing to one or more qualified charitable organizations. Payments may continue for the lifetime of one or more beneficiaries or for a fixed term of up to 20 years. Because the trust is irrevocable, clients generally cannot take back assets once they have contributed them. To qualify as a CRT, the actuarial value of the charitable remainder interest, calculated when the trust is funded, must equal at least 10% of the fair market value of the trust at inception.¹

How does a charitable remainder trust work?

Although individual arrangements vary, a CRT generally follows four steps:

1. The client establishes and funds a CRT. After consulting with a tax advisor, the client works with an estate planning attorney to establish the trust and then transfers in cash, securities or other property. The client may qualify for a partial charitable income tax deduction based on the actuarial value of the charitable remainder interest, subject to applicable limitations. Highly appreciated assets may be particularly attractive candidates when diversification and charitable giving are both planning priorities for the client.

2. The trustee can sell and reinvest the assets. A CRT generally is exempt from U.S. federal income tax,² allowing the trustee to sell appreciated assets without the trust incurring capital gains tax at the time of the sale. The trust can then reinvest the proceeds, potentially allowing a client to diversify a concentrated position without triggering the same immediate tax consequences that would result from selling the assets personally.

3. The CRT makes annual payments to its non-charitable beneficiaries. The client, a spouse or other named individuals may receive payments for their lifetimes or for a specified term of up to 20 years. Those distributions generally are taxable to non-charitable beneficiaries, depending on the income and gains accumulated within the trust. If someone other than the client or their spouse is named as a beneficiary, the transfer of that income interest may also have gift tax consequences for the client.

4. The remaining assets pass to charity. When the payment period ends, either at the end of the specified trust term or upon the death of a designated lifetime beneficiary (or beneficiaries), the remaining trust assets pass to one or more qualified charitable organizations.

CRAT vs. CRUT: What's the difference?

While charitable remainder trusts can be structured in different ways, CRATs and CRUTs are the two primary types. The key distinction for an advisor to know is how the annual payment is calculated.

A charitable remainder annuity trust (CRAT) pays a fixed dollar amount each year to the non-charitable beneficiary (or beneficiaries) based on the initial value of the assets contributed to the trust. The annual payout must generally equal at least 5% but no more than 50% of the initial fair market value of the trust property. Because the dollar payment is fixed when the trust is established, it does not increase or decrease as the value of the trust changes.

A charitable remainder unitrust (CRUT) instead pays a fixed percentage of the trust's net fair market value, which is recalculated annually. The percentage must also generally fall between 5% and 50%. As a result, the dollar amount distributed to the beneficiary can rise or fall with the value of the trust.

This distinction can matter when helping clients think through their income needs.

How are CRT distributions taxed?

A CRT generally is not subject to U.S. federal income tax when appreciated assets within the trust are sold. That does not mean the capital gain disappears. Instead, accumulated income and gains may become taxable to non-charitable beneficiaries over time as distributions are made.

CRT distributions to non-charitable beneficiaries are generally characterized for tax purposes in the following order: ordinary income → capital gains → other income (including tax-exempt income) → return of principal.

The precise tax treatment of each distribution depends on the trust's current and accumulated income and gains, making coordination with the client's tax professional important.

What charitable deduction may the client receive?

Funding a CRT may generate a federal income tax deduction, but the client generally cannot deduct the full value of the assets transferred. Instead, the deduction is based on the present value of the charitable remainder interest when the CRT is funded. The allowable deduction is also subject to adjusted gross income and other applicable limitations that will vary by taxpayer.

When might a charitable remainder trust make sense?

A CRT may be especially worth discussing when several client needs come together. Look for clients who:

• Have meaningful charitable intentions.
• Own highly appreciated assets, such as concentrated stock, that they would like to sell or diversify.
• Want to maintain a predictable income stream for themselves or another beneficiary.
• Do not expect to need direct access to the contributed assets.
• Are comfortable making an irrevocable commitment that ultimately directs the remaining trust assets to charity.

A CRT should not be viewed merely as a way to defer capital gains taxes. The charitable remainder is fundamental to the structure, and assets transferred to the trust generally cannot be reclaimed.

Questions to ask clients when considering a CRT

You may be the first member of a client's professional team to recognize that their investments and charitable goals create a potential CRT opportunity. Consider asking:

• Do you plan to make a meaningful charitable gift during your lifetime or as part of your estate plan?
• Do you own highly appreciated investments that you would like to sell or diversify?
• Would an ongoing income stream support your financial plan?
• How much income do you need from the assets you are considering transferring?
• Would you be comfortable permanently committing those assets to a trust knowing that the remainder will ultimately pass to charity?
• Who should receive income from the trust, and for how long?

These conversations can help surface the client's priorities before you or your client collaborate with an estate planning attorney and tax professional to determine whether and how a CRT should be structured.

How Maria’s advisor helped her address multiple needs with a CRT: a hypothetical example

Maria (a hypothetical client) owned highly appreciated stock and wanted to diversify her holdings. She also needed an annual income stream for the rest of her life and planned to donate her remaining wealth to a particular charity upon her death. She didn’t expect to have other financial needs and was comfortable locking up her assets in an irrevocable trust. Her advisor suggested consulting with her estate planning attorney and tax professional to determine whether a charitable remainder trust might be an appropriate strategy for her needs.

In collaboration with her team of professionals, Maria established a CRUT and funded it with her appreciated stock. She named herself as the lifetime beneficiary of the CRUT, receiving annual payouts equal to 7% of the trust’s assets, which will be revalued each year, and she designated a qualifying charitable organization as the beneficiary of the assets remaining in the trust at her death. Her trustee sold the appreciated shares and reinvested the proceeds in a diversified portfolio.

Because CRTs are generally exempt from federal income tax, the sale did not result in a U.S. federal capital gains tax liability for the trust. As Maria receives annual payments from the CRUT, portions of the trust's accumulated income and capital gains may be included in those distributions and become taxable to her over time.¹

Choosing a CRUT as the vehicle to transfer her wealth to charity also met Maria’s need for an ongoing income stream and helped her diversify her appreciated assets while deferring the capital gains tax over a number of years. By understanding the basics of CRTs, her advisor was able to recognize the potential opportunity for Maria and deliver value as an advisor.

Bring charitable giving into the broader wealth plan

Charitable planning can intersect with investment management, income needs, taxes and estate planning. That puts you in a valuable position to help clients consider these decisions together.